A structural model of guarantor and liquidity risk

44 Pages Posted: 2 Dec 2020 Last revised: 8 Jan 2021

See all articles by Alexandros Bougias

Alexandros Bougias

Athens University of Economics and Business - Department of Accounting and Finance

Athanasios Episcopos

Athens University of Economics and Business - Department of Accounting and Finance

Date Written: September 1, 2020

Abstract

We develop a structural model that accounts for guarantor risk and state-dependent withdrawals that induce liquidity funding costs for the bank. The severity of these costs increases near the default barrier, where depositors run on the bank for fear of a costly recovery. The introduced frictions reduce the bank charter value and lead to lower levels of optimal leverage. Our model provides a tool for examining the effectiveness of different regulatory and deposit insurance policies. Minimum capital requirements successfully mitigate asset substitution and moral hazard problems, even in regimes with capital forbearance and mispriced deposit insurance. We introduce a new measure, the reservation price of deposit insurance, defined as the highest premium that makes deposit insurance irrelevant to the bank. The reservation price is significantly low when the guarantee fund provides limited coverage and has not prevented bank runs, thus forcing the guarantee fund to levy a lower assessment rate.

Keywords: Deposit insurance, capital regulation, structural models, bank capital structure

JEL Classification: G13, G21, G33

Suggested Citation

Bougias, Alexandros and Episcopos, Athanasios, A structural model of guarantor and liquidity risk (September 1, 2020). Available at SSRN: https://ssrn.com/abstract=3713794 or http://dx.doi.org/10.2139/ssrn.3713794

Alexandros Bougias

Athens University of Economics and Business - Department of Accounting and Finance ( email )

76 Patission Street
GR-104 34 Athens
Greece

Athanasios Episcopos (Contact Author)

Athens University of Economics and Business - Department of Accounting and Finance ( email )

76 Patission Street
GR-104 34 Athens
Greece
+30 21 0820 3364 (Phone)
+30 21 0822 8816 (Fax)

HOME PAGE: http://www.aueb.gr/users/episcopos

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
17
Abstract Views
207
PlumX Metrics